Investing In America's Future
The Los Angeles Unified School District recently borrowed $1.37 billion to finance improvements to schools throughout the Los Angeles area at a 25-year cost of 3.67%. Financing these school improvements in the traditional tax-exempt bond market would have cost LA USD approximately 4.26%.
This 59-basis-point difference translates into more than $11.4 million of interest savings per year and more than $250 million in savings over the next 25 years--money that can be put to use purchasing 114,000 school desks or 455,000 textbooks each year.
LA USD was able to lower its interest costs and save money for construction and improvements thanks to the American Recovery and Reinvestment Act. The Act created the Build America Bonds (BABs) program, under which state and local governments can finance capital projects in the taxable bond market--rather than in the traditional tax-exempt market--and receive a 35% rebate on their interest costs.
The BAB program is set to expire at the end of 2010. But Congress should not only consider extending the duration of the program but expanding its breadth to include all financings. The program has been, by all measures, a huge success for state and local governments. It has provided municipalities with lower-cost funding to build schools, repair bridges, improve highways and address other vital public needs. BABs have allowed taxable investors to invest in the high-quality credits of our state and local governments.
Overwhelming interest in BABs has reduced the supply of tax-exempt bonds and driven down costs even for issuers who prefer to finance themselves in the traditional municipal bond market. Non-traditional municipal investors, including pension funds, endowments and insurance companies, are now competing for the debt of state and local governments by buying taxable BABs.
States and localities have long been able to borrow money for infrastructure and other essential services by issuing bonds whose interest is exempt from federal income tax. This in turn lowers the interest that municipalities must offer to attract investors. Like many financial markets in late 2008, the tax-exempt one was severely stressed as companies that insured bonds of all types faltered, the auction rate market collapsed and investors in long-term bonds fled to shorter maturities and Treasury-backed assets.
Local governments that needed to fund infrastructure projects were forced to borrow--if they could borrow at all--at rates over 7%. Congress and the administration responded quickly by rethinking how municipalities could access the capital markets, creating an alternative approach to traditional tax exemption. The answer: Build America Bonds.
The issuance of over $45 billion in BABs already saved taxpayers an estimated $360 million in annual interest relative to borrowing in the tax-exempt market, money that can be put to use for the benefit of taxpayers rather than to pay debt service. Equally important, market efficiencies created by BABs as a competitive financing alternative have lowered the borrowing costs in the tax-exempt market for projects not currently eligible for BABs--hospitals, universities, airports, rails and others--as well as the costs for refinancing debt and working capital.
To be sure, the tax-exempt market continues to serve as an effective capital source for state and local governments and an attractive option for issuers and investors. Coupling the traditional tax-exempt market with an expanded BAB program would further increase the efficiency of both markets, which would prove a boon to all Americans.
Given the fragility of the economy and constrained state and local budgets, ensuring our capital markets are as efficient as possible is critical. Extending the BAB program would do this and more by being both cost effective directly addressing some of the challenges facing our nation's municipalities. Broadening the benefits created by the BAB program to the entire municipal bond market would allow LA USD and others to refinance their existing debt for additional savings. One can only start to list the more productive ways that such savings could improve our country's schools, bridges, highways and water systems.
As a permanent solution, the Build America Bond program would allow more investors to fund state and local infrastructure projects at a lower cost to taxpayers. This would create jobs and revive long-term economic growth with the ability to be designed to have zero net cost to the U.S. Treasury given the benefits of issuing less tax-exempt debt. In short, BABs are a win for taxpayers, for state and local governments, for investors, for job creation, for the economy and, by extension, for America's future. The benefits to extending and expanding the program would reverberate widely and help sustain the country's economic recovery while investing in our future.
Jim Esposito is managing director of Goldman Sachs and global head of Investment Grade and Municipal Financing Group.